Spinoffs: A Buy, If You Can Stomach The Ride

By Brendan Conway

Buying a spinoff company often makes sense if you can stomach the volatility, Credit Suisse’s (CS) latest quantitative look at the subject reminds us.

Over the past 17 years, spinoffs have enjoyed a pretty robust outperformance of the Standard & Poor’s 500-stock index (SPY), the firm’s data show. At the get-go, it may not appear that way. Spinoffs underperform for their first 27 trading days on average, report CS quants Pankaj N. Patel, Souheang Yao, Ryan Carlson, Abhra Banerji and Joseph Handelman.

But by day 60, the excess return versus the benchmark was 2.2%. (As it happens, the parent companies also averaged a 2.2% advantage.) Then, the lead widens out after a year.

It’s a pretty wide lead, too. The 12-month outperformance is 9.6% for the parent and 13.4% for the spinoff, according to CS’s findings. The downside: CS finds an 11.7% standard deviation for the parent and 16.1% for the spinoff in the first 30 trading days.

In other words, buckle in if you want to enjoy the ride with the likes of Beam Inc. (BEAM), up 19% YTD, and Fortune Brand Home & Security (FBHS), up 53%.

This is no guarantee of good results buying, say, Kraft Foods (KFT) and its future spinoff, Kraft Foods Group (KRFT), or McGraw Hill Cos. (MHP) and its soon-to-be-independent education division.

But the exchange-traded fund business (naturally) has a way to buy the group. This should, in theory, minimize the effects of one or two bad results.

The Guggenheim Spinoff ETF (CSD) tracks 25 companies with an average $3.7 billion market cap. The lightly owned fund — it has about $37 million in assets — has enjoyed a 13% gain this year, or pretty close to even with the S&P 500.

Moreover, you’ll probably end up buying spinoffs at various stages in their lives as newly public companies. Bill Mitchell, CEO of Spinoff & Reorg Profiles, a Costa Mesa, Calif.-based research outfit, noted in a piece by Mike Hogan of Barron’s last July that the fund is rebalanced semiannually. Read Hogan’s piece here for more detail.

Finally, investors should always make note of expenses. This one is capped at 0.60%, which is considerably above the cost of a plain vanilla ETF.

About Focus on Funds

As exchange-traded funds and other investing vehicles have ballooned in number, the task of figuring out what works well and what doesn’t has only gotten harder. Barrons.com’s Focus on Funds looks under the hood of ETFs, mutual funds and hedge funds for overlooked values, actionable ideas and the latest pitfalls for fund investors.